The Issue

Reducing the Strategic Importance of Oil

Until the beginning of the 19th century salt was one of the world's most strategic commodities. As the only means of food preservation, it was fundamental to national economies. Salt deposits conferred national power and wars were even fought over their control. Countries that controlled salt aimed to keep production tight and prices high so as to extract maximal revenue for their treasuries. Eventually, competing means of preserving food - canning, electricity and refrigeration - decisively ended salt's monopoly over food preservation and with it its strategic importance.

Petroleum today occupies the strategic ground that salt did many years ago.

The U.S. consumes a quarter of the world's oil yet has only three percent of the world's conventional oil reserves. As a result, it must import more than half of its oil and this figure is growing. Because the vast majority of the world's oil is controlled by regimes that are undemocratic and/or hostile to the U.S. this dependency undermines U.S. national security. There are also concerns about the negative impact on American interests of China and India's growing demand for energy. The two countries' foreign policies are increasingly driven by the need to secure their energy supply, often at the expense of vital U.S. interests.

Oil dependence also impacts the U.S. economy. Oil crises over the last half century – including the one in 2007-2008 - have generally been followed by economic downturns. Oil imports constitute a full half of the U.S. trade deficit. At current oil prices, more than one billion dollars – money that domestically could have created jobs and investment opportunities – are transferred daily overseas to finance America's petroleum requirements. The amount of money expended on oil imports annually is larger than the total value of the homes that went into foreclosure since the onset of the Great Recession.

Redefining the problem: It's not about imports, it's about salt.Oil's status as a strategic commodity does not stem from the magnitude of petroleum imports nor even from the sources of those imports. The U.S. uses more salt now than ever before, yet nobody is particularly concerned about the magnitude of U.S. salt imports. In 2008, the UK produced most of the oil it needed, yet the global oil price spike affected all consumers, including those in the UK, where it resulted in protests by frustrated truckers. Just as salt's strategic importance derived from its monopoly over food preservation, oil's derives from its virtual monopoly over transportation fuel. Over the past four decades, eight presidents tried to reduce America's oil dependence but, despite some tactical progress, were unsuccessful, and each passed to his successor a country that was more, rather than less, dependent on oil. One of the reasons for this failure is that they all focused on reducing the level of oil imports when the real problem is oil's status as a strategic commodity which stems from its virtual monopoly over transportation fuel.

It's not about electricity, it's about transportation.Transportation, not electricity, is the source of oil's importance: since the 1970s, the U.S. has weaned its power sector off of oil. Today only one percent of U.S. electricity is generated from oil and only one percent of U.S. oil demand is due to electricity generation. Thus expansion of electricity generation from solar, wind, nuclear, and other power sources will not serve to displace oil in any perceptible manner. Plug in an electric vehicle today and 99% of the electricity its battery is charged with will not be generated from oil, and given the amount of off peak electric grid reserve capacity this will still be the case as vehicle electrification proliferates.

Reducing the strategic importance of oil: tactical approaches aren't sufficientHistorically the U.S. has focused on policies that increase either the availability of petroleum or the efficiency of its use. These approaches are tactical rather than strategic. Reducing oil demand through fuel economy absent competitive markets in transportation fuels and transportation modes, while it serves to reduce the trade deficit as well as emissions, is insufficient to change the strategic status of oil. When oil-consuming countries increase their domestic production or reduce net demand, the Organization of Petroleum Exporting Countries (OPEC), the oil cartel which controls 79 percent of global reserves, can respond by throttling down supply to drive prices back up.

Needed: competitive marketsTo reduce the strategic importance of oil, the market must have viable choices that enable consumers to respond quickly to changes in oil prices not by constricting their economic activity but by substituting for oil and/or driving with a competing good or service. Drivers can't rapidly change the fuel economy of their vehicles, but, with vehicles that enable fuel competition they could quickly change what fuel their vehicles use, and with a competitive market among transportation modes, they could quickly change how frequently they use those vehicles.

Fuel competition A competitive market among transportation fuels would place a de facto ceiling on the price of oil once market penetration of vehicles that enable fuel competition is sufficiently high: If oil surpasses the threshold price at which competing fuels are economic (on a cost per mile comparison,) then consumers whose vehicles enable choice will choose to fuel with substitutes.

For a cost of roughly $100 extra as compared to a gasoline-only vehicle, automakers can make virtually any car a flex fuel vehicle (FFV,) capable of running on any combination of gasoline and a variety of alcohols such as methanol and ethanol, made from a variety of feedstocks. While ethanol is made from agricultural products like sugar cane and corn, methanol can be made from natural gas, coal, any form of biomass, and in the future, perhaps recycled carbon dioxide. As noted by a recent MIT study, should the economics of natural gas in the U.S. remain favorable due to progress in shale gas extraction, delivering that natural gas to the vehicle would be most economic from an infrastructure and vehicle perspective if it is converted to methanol and vehicles are flex fueled.

Flex fuel vehicles provide a platform on which liquid fuels can compete, thus placing a variety of commodities in competition at the pump and letting the market determine the winning fuels and feedstocks based on economics - that is, the comparative cost per mile. The proliferation of flex fuel vehicles in Brazil has driven fuel competition at the pump to the point where in 2008, when oil prices were at record highs, more ethanol was used in Brazil than gasoline.

An Open Fuel Standard ensuring new cars are gasoline-ethanol-methanol flex fuel vehicles would serve as a low premium insurance policy against excessive oil price rises. It is a critical, yet low cost, pathway to breaking oil’s virtual monopoly over transportation fuel and thus reducing its strategic importance. In the absence of an Open Fuel Standard, most of the 10-15 million new vehicles that roll onto America's roads every year, each with a street life of over 16 years, will be unable to use anything but petroleum fuels.

Electric cars and plug-in hybrid electric vehicles (PHEVs) place electricity - which in most oil importing countries is for the most part not generated from oil - in competition with liquid fuel. The strategic importance of vehicle electrification derives from the much lower cost-per-mile of fueling with electricity as compared to the cost of fueling with gasoline or diesel, even when oil prices are relatively low. The upfront cost of electrified vehicles is higher, but this cost should drop as the technology evolves and production scales increase. Tax credits for plug in hybrid and electric vehicles keyed to battery size have been enacted into law as a policy tool aimed at moving this technology past the early adopter hump and into the mass market.

Vehicle electrification, though it will take much longer to proliferate, should be viewed as complementary to liquid fuel choice. Combining the technologies into flex-fuel plug-in hybrid electric vehicles enables electricity and alcohols from a variety of energy sources to compete against petroleum based fuel every time the consumer makes a fuel purchase.

Competition among transportation modesA competitive market among transportation modes would increase economic resilience by reducing the ability of an oil price spike to wreak economic havoc. This is readily apparent in the case of tele-working or teleshopping: the larger the portion of economic activity that can be accomplished on an internet highway rather than a physical one, the less impact an oil price spike would have on our economy.Economic resilience is also increased by competition among physical transportation modes (car, shuttle, bus, train, plane or even biking or walking). Should the price of oil rise above a threshold at which the cost of driving a car becomes unaffordable, a competitive market would allow people to rapidly switch to modes of transport that offer lower costs of travel per mile per passenger and still engage in day-to-day activities.

The role of governmentAs economic growth resumes and the global appetite for oil grows, we can expect prices to hit record highs again, to the detriment of the global economy. A fleet wide deployment of vehicles that enable fuel choice could take place relatively quickly. It will take more time to open the market to competition among transportation modes. But such transformations will not occur by themselves. Economic theory clearly shows that market forces alone are incapable of breaking cartels and monopolies. It is the role of government to fight anti-competitive behavior, dismantle monopolies and cartels and unleash free market forces to take their course. It will require committed leadership for the U.S. to break oil's virtual monopoly over transportation fuel. Placing oil into competition with other energy commodities will not only drive down the its price, it will also alter the geopolitical balance of power in favor of net oil importers and countries with resources to become non-petroleum fuel producers.

"The first and most urgent necessity in the area of government policy is the elimination of those measures which directly support monopoly." Milton Friedman